Balanced funds are a type of mutual fund that offers a balanced mix of equities and fixed-income securities. They aim to provide a balance of growth, income, and preservation of capital. Let’s delve deeper into the world of balanced funds.
What are Balanced Funds?
A balanced fund is a type of mutual fund that owns both stocks and bonds. Balanced funds own stocks to benefit from appreciation, and generate income from bonds. Typically, stocks comprise from half to 70% of a balanced mutual fund’s portfolio, with bonds accounting for the rest.
How do Balanced Funds Work?
Balanced funds work by investing in a mix of assets to achieve a balance of risk and return. These funds typically stick to a fixed asset allocation of stocks and bonds, such as 70% stocks and 30% bonds. The investment objective for a balanced mutual fund tends to be a mixture of growth and income, which leads to the balanced nature of the fund.
Benefits of Investing in Balanced Funds
Balanced funds can benefit investors with a low risk tolerance, such as retirees, by offering capital appreciation and income. They provide a healthy mix of stocks and fixed-income instruments that help in limiting the downside risks of equity markets. Balanced funds are best suited for every long-term investor.
Understanding Balanced Funds
A balanced fund is a type of hybrid fund, which is an investment fund characterized by its diversification among two or more asset classes. The amounts the fund invests into each asset class usually must remain within a set minimum and maximum value. Another name for a balanced fund is an asset allocation fund.
Disadvantages of Balanced Funds
While balanced funds are a popular investment choice due to their mix of equities and fixed-income securities, they also come with certain disadvantages. Let’s explore these in detail.
1. Limited Returns
One of the main disadvantages of balanced funds is their limited returns. These funds typically generate low single-digit returns, which are often lower than those of riskier investments like stocks or corporate debt issues.
2. Inflation Risk
Inflation risk is another significant disadvantage of balanced funds. If the rate of inflation is higher than the return generated by the fund, investors essentially lose purchasing power each year.
3. Lack of Federal Insurance Protection
Unlike bank savings accounts, balanced funds do not have Federal Deposit Insurance Corporation (FDIC) protection¹. This means that while the risk of losing money in these funds is low, it is not zero.
4. Vulnerability to Market Conditions
Balanced funds are not immune to market conditions. In periods of extremely low or negative interest rates, these funds can potentially yield negative returns.
5. Management Fees
Management fees can eat into the returns of balanced funds. These fees are charged for the professional management of the fund and can be higher for actively managed funds.
6. Loss of Opportunity
Due to their low returns, investing in balanced funds could mean missing out on potentially higher returns from other types of investments.
7. Status Asset Allocation
Balanced funds allocate funds in a status ratio of 60/40, which isn’t always the best mix.
8. Dependence on Fund Manager
The performance of your fund depends on the expertise of the fund manager who manages the fund. Your fund manager must be proficient in asset mixing.
Conclusion
Balanced funds can be a great investment option for those who are looking for a balanced mix of safety, income, and modest capital appreciation. However, it’s important to understand the different types of balanced funds and their strategies before investing. Always remember to do your own research and consider your financial goals and risk tolerance before making any investment decisions.